An extremist, not a fanatic

November 01, 2012

Friedman's failure

The important thing is to establish a climate of opinion which will make .. the wrong people do the right thing.

By this standard, however, Friedman and his followers have failed in some respects. My chart shows one.It shows that there has recently been a close correlation between inflation expectations and the S&P 500, with higher inflation expectations associated with higher share prices. This suggests that the stock market disagrees with Friedman. He thought the optimal inflation rate was slightly negative. Stock markets clearly think it's positive. They - rightly or wrongly - don't want sound money.

This is not the only way in which business is anti-Friedmanite. Tim points out, as I have, that businessmen believe in central planning; it is, after all, what they do. And you'll not find many enthusiasts for a minimal state on the boards of Capita or BAe Systems.

I don't say this merely to remind you that there's a big difference between pro-market policies and pro-business ones. I've often complained that there's no constituency to press for sensible leftist policies. But there's no constituency to press for Friedmanite ones either.

TrackBack

Comments

You can follow this conversation by subscribing to the comment feed for this post.

might the mechanism here be that, at the moment, inflation expectations are tied to QE, and QE drives up asset prices (rather than asset prices rising because stock market investors think positive inflation is in some sense good)

Yes, Luis - that's one mechanism. But it's not the only one, as the positive correlation predates QE: it also existed, to a lesser extent, between 2003 and 2008.
But I don't think this invalidates the point. The fact is that the market is not spooked by the prospect of (slightly) higher inflation.

If the market monetarists are the heirs to Friedman, then I don't think he would be against QE (or some other perhaps better targeted monetary expansion) right at this moment. There is a difference between being against excess inflation generally and being against it after a massive nominal shock (like a collapse in credit) that economies have yet to recover from.

Most leading Chicago School neoliberals recognised the point you make, which is why they were so suspicious of democracy. They never believed that their policy program would be popular, which is why they often supported policy-making via non-democratic channels (including the Pinochet regime...). Schumpeter also argued that there is no constituency for innovative capitalism, and hence socialism would eventually destroy it.

Friedman hasn't just failed to convince stock market investors they'd be better off under slightly negative inflation, he's failed to convince mainstream economists. As far as I know, economists who most people would usually accuse of being "neoliberal" predominantly think the optimal rate of inflation is slightly positive ... although having written that, I found this paper

that says most mainstream monetary theories still side more with Friedman. So perhaps the reasons why we tend to see positive inflation - the one I come across the most being that it allows downward real wage adjustments without downward nominal adjustments - haven't made their way into theoretical models.

Chris, I think you have made an error (Although I am happy to be corrected).

Imagine the real value of stocks does not change. You buy a $100 of stocks and think that this is the true value of the stock in 2011. There is 5% inflation over the year. What amount of money would you now want to exchange your stocks for in 2012?

$100? No. Not if the real value of the stocks hasn't changed. The value of your stocks in 2012 is $105 because the value of money has fallen.